Lack of competition keeps inflation up

It is the lack of competitive pressure in product markets – rather than labour markets – that is keeping Australian inflation stubbornly high.

As a result, though there is no doubt scope for greater labour market flexibility in some pockets of the economy, both state and federal governments also need to urgently review competition and pricing policy in areas such as education, health and utilities.

This much is evident from the latest report on wages growth during the December quarter.

It’s hard to argue that aggregate wage growth is anything other than well behaved, and has slowed by as much as could be reasonably expected given the softness in labour demand.

AFR
AFR

An upsurge in wages can’t be blamed for the higher than expected consumer price inflation result last quarter.

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The private-sector wage cost index (excluding bonuses) rose only 0.6 per cent in the December quarter, after an equally muted gain of 0.5 per cent in the September quarter.

Over the course of 2013, private sector wages grew by only 2.5 per cent – the weakest annual pace since this measure of wages was created in the late 1990s.

Annual wage growth was running closer to 4 per cent only as recently as mid-2012, and has averaged 3.5 per cent since the late 1990s.

The slowing in wage growth affirms the view that the weakness in employment growth and lower workforce participation evident of late is not merely the result of older workers leaving the jobs market.

There has been a clear cyclical weakening in employment conditions – as has also been evident from the decline in job vacancies and rise in household fears of unemployment through much of last year.

What’s more, contrary to claims that the labour market is a lot less flexible than it used to be, private sector wages have slowed by a similar degree – if not more – than seen in past economic cycles.

Indeed, the current wage slowdown is consistent with that during the last major downturn in the labour market demand during the global financial crisis.

In late 2009 and early 2010, annual private-sector wage growth slowed to 2.6 per cent – in response to a rise in the unemployment rate to almost 6 per cent in mid-2009.

In fact, if anything, wage growth now appears more responsive to shifts in labour market demand than evident earlier last decade.

In the 12 months to October 2001, for example, the unemployment rate rose from 6 per cent to 7.2 per cent.

Yet annual private sector wage growth kept rising through most of this period – until it peaked at 3.7 per cent in June 2001.

Annual wage growth then only slowed to 3.2 per cent over the following year.

Aggregate labour market flexibility is not too surprising, given that only 13 per cent of private sector workers are now trade union members.

Calls for grand compact laughable

In turn, that also renders appeals by some energetic union officials for a renewed “grand compact" between unions and business somewhat laughable.

The world has changed.

Unions cannot and should not ever expect to have such economy-wide influence over policy making as last evident during the 1980s.

That said, there is no doubt scope for greater union-business co-operation in the few remaining pockets of the economy where unions are a force.

Indeed, pockets of labour market inflexibility no doubt remain, and the Labor government’s re-regulation in areas – such as a rise in some penalty rates – has caused such concern among business that it even led to public comments by Reserve Bank of Australia governor
Glenn Stevens
.

But, to my mind, labour market regulation is increasingly a second order “micro-economic" problem, rather than first-order “macro-economic" concern.

Of course, all this begs the question: if wages are so benign, why did consumer price inflation surprise on the upside last quarter?

The rise partly reflected a lift in import prices due to the decline in the Australian dollar, but the greatest surprise was that prices in areas less subject to international competition – “non-tradeables" – remained at a stubbornly high annual rate of 3.7 per cent, or only a little below the long-run average.

That led the RBA to note last week “It is somewhat surprising that non-tradables price inflation has not eased, given that growth in labour costs has been weak in recent quarters."

While lags could be at play, I’d also blame political neglect of the lack of competitive pressure in many sectors not subject to international competition – such as health, education, and utilities.

This appears to reflect pockets of excess demand in areas where government have encouraged greater use of privately provided services – without helping to expand supply or ensure enough competitive discipline over providers.

In fact, expensive government subsidies for some private services – such as childcare and health insurance – seem to only encourage providers to raise prices even more.

Ironically, although politicians often shed crocodile tears over cost-of-living pressures, it’s their own neglect of rocketing costs in areas under their own control that seems largely to blame.